UNAM 1 – The profit investment nexus

My first lecture to the economics faculty of the Autonomous National University of Mexico (UNAM) was on the relationship between profits and profitability and investment and economic growth in capitalist economies. Do profits and profitability lead investment and GDP into slumps and out of them, or vice versa?  In my view, this is one of the big divisions between the Keynesian and Marxist theory of crises, or booms, slumps and depressions in capitalism. For all the references to research etc made below, see my paper: The profit investment nexus

In my presentation, I first pointed out that both Marxist and Keynesian analysis agree that investment (especially business investment) is the key driver of economic growth and the main swing factor in the capitalist business cycle of boom and slump.  This is contrary to the view of neoclassical theory, where in so far as it has any theory of crises at all, it starts from the premiss that the ‘consumer is king’ and that the ups and downs of consumer demand explain booms and slumps.  At least, the more sophisticated version of Keynesian theory recognises ‘effective demand’ (the Keynesian indicator of crises) under capitalism is primarily investment, not consumption – although many Keynesians seem to slip into the latter as the cause.

If we analyse the changes in investment and consumption prior to each recession or slump in the post-war US economy, we find that consumption demand has played little or no leading role in provoking a slump.  In the six recessions below, personal consumption fell less than GDP or investment on every occasion and does not fall at all in 1980-2.  Investment fell by 8-30% on every occasion.

But after that comes the difference with Marxist analysis.  The Keynesian macro-identities suggest that investment drives GDP, employment and profits through the mechanism of effective demand.  But Marxist theory says that it is profit that ‘calls the tune’, not investment.  Profit is part of surplus value, or the unpaid labour in production.  It is the result of the exploitation of labour – something ignored or denied by Keynesian theory, where profit is the result of ‘capital’ as a factor of production.

In my presentation, I argued that Keynesian macro-identities are thus ‘back to front’: investment does not ‘cause’ profit; profit ‘causes’ investment.  Moreover there is little empirical evidence that investment drives profits as the Keynesian model would suggest. And there is little evidence that government spending or budget deficits (net borrowing) restore economic growth or end slumps.  These end only when the profitability of business capital is revived.  Thus the Keynesian multiplier is less compelling than the ‘Marxist multiplier’.

For Keynesians, the causal direction is that investment creates profit. For orthodox Keynesians, crises come about because of a collapse in aggregate or ‘effective demand’ in the economy (as expressed in a fall of investment and consumption).  This fall in investment leads to a fall in employment and thus to less income.  Effective demand is the independent variable and incomes and employment are the dependent variables.  There is no mention of profit or profitability in this causal schema.

Keynes understood the central role of profit in the capitalist system. “Unemployment, I must repeat, exists because employers have been deprived of profit. The loss of profit may be due to all sorts of causes. But, short of going over to Communism, there is no possible means of curing unemployment except by restoring to employers a proper margin of profit.” But for him, and Michal Kalecki, the guru of post-Keynesian analysis of crises, investment creates profits not vice versa.  “Nothing obviously, can restore employment which does not first restore business profits. Yet nothing, in my judgement, can restore business profits that does not first restore the volume of investment.”  (Keynes).  To use the pithy phrase of Hyman Minsky, devoted follower of Keynes, “it is investment that calls the tune.”

As Jose Tapia has pointed out that “for the whole Keynesian school, investment is the key variable explaining macroeconomic dynamics and leading the cycle.”  But if investment is the independent variable, according to Keynes, what causes a fall in investment? For Keynes, it is loss of ‘animal spirits’ among entrepreneurs, or a ‘lack of confidence’ in employing funds for investment.  As Minsky said, investment is dependent on “the subjective nature of expectations about the future course of investment, as well as the subjective determination of bankers and their business clients of the appropriate liability structure for the financing of positions in different types of capital assets”

As Paul Mattick Snr retorted about the Keynesian explanation, “what are we to make of an economic theory, which after all claimed to explain some of the fundamental problems of twentieth-century capitalism, which could declare: ‘In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends’?

In my presentation, I suggested that what if we turn the causal direction the other way.  Marx’s theory of value tells us that all value is created by labour and profit is a product of the exploitation of labour power and its appropriation by capital.  Then we have a theory of profit and investment based on an objective causal analysis within a specific form of class society.  And now, investment in an economy depends on profits.

With Marx, profit is the result of the exploitation of labour (power) and thus is logically prior to investment.  But it is also temporally prior.  If we adopt a theory that profits cause or lead investment, that ‘profits call the tune’, not investment, then we can construct a reasonably plausible cycle of profit, investment and economic activity.

And not only is this the Marxist approach theoretically more realistic and valid, there is a wealth of empirical evidence to support the analysis that profits lead investment, not vice versa.  I gave a long list of studies along these lines, from both mainstream and Marxist analysts, including my own (see my paper above).

My presentation then went on to draw the policy conclusions from the difference between Keynesian and Marxist analysis.  It is the kernel of Keynesian economic policy that the way out of economic recession under capitalism is to boost ‘effective demand’. And in a ‘depression’, it will be necessary to stimulate this demand, either by easing the cost of investment or consumer borrowing (monetary policy) and/or by government spending (fiscal policy).

But if the Marxist analysis is right, then this is a utopian policy. Government spending and tax increases or cuts must be viewed from whether they boost or reduce profitability. If they do not raise profitability or even reduce it, then any short-term boost to GDP from more government spending will only be at the expense of a lengthier period of low growth and an eventual return to recession.

There is no assurance that more spending means more profits – on the contrary.  Government investment in infrastructure may boost profitability for those capitalist sectors getting the contracts, but if it is paid for by higher taxes on profits, there is no gain overall.  And if it is financed by borrowing, profitability will eventually be constrained by a rising cost of capital.

I then outlined a load of empirical evidence to show that the so-called Keynesian ‘multiplier’ of government spending boosting real GDP growth was ineffective, and the ‘Marxist multiplier’, to coin the term from G Carchedi, that investment and growth under capitalism only really responds to changes in profitability and profits, was way more compelling.

I compared average real GDP growth against the average change in government spending and as a ratio of the change in the net return on capital for successive decades since 1960.  Real GDP growth is strongly correlated with changes in the profitability of capital (Marxist multiplier), while the correlation was negative with changes in government spending (Keynesian multiplier).  The Marxist multiplier was considerably higher in three out of the five decades, and particularly in the current post Great Recession period.  And in the other two decades, the Keynesian multiplier was only slightly higher and failed to go above 1.

There was some discussion from the floor about the validity of econometric causal analysis in reaching these results and their statistical significance.  But I think we can safely say that there was stronger evidence that the Marxist multiplier is more relevant to economic recovery under capitalism than the Keynesian multiplier.

In her commentary on my presentation, Professor Gloria Martinez from UNAM, carefully considered my arguments, making the point that it was not a fall in profitability that was the direct cause of slumps, but in particular, the eventual fall in the mass of profit.  And so there is an issue of how crises can take place when the rate of profit is rising, as it was in the neo-liberal period from the 1980s.

Well, there are several responses to that.  First, many studies show that the overall rate of profit in the US and elsewhere stopped rising after the end of the millennium – the neoliberal recovery was over.  Indeed, profitability in the US began to fall from 2006, well before the credit crunch and the Great Recession, as did eventually the mass of profit.  So the Marxist analysis still holds.

Second, as Carchedi has shown, if you strip out the counteracting factor of a rising rate of surplus value from the 1980s, the law of profitability ‘as such’ was still operating.  Indeed, crises occur when total new value (wages and profit) fell or slowed markedly and Marx’s law of profitability then asserted itself.

The other response comes from the issue of fictitious profits and the rise of finance capital in the neo-liberal period, but particularly after 2002.  This was raised by several members of the audience.  After 2002, total profits in the US rose sharply but investment did not follow.  So where was the profits-investment nexus then?  Well, if you strip out the profits from fictitious capital (financial speculation in stocks and bonds with credit), then profitability was falling from 2002 – this is what a study by Peter Jones from Australia has shown (see paper).

Second, if you strip out finance capital profits (not all of which is fictitious because interest income and commissions are revenue for banks and finance houses), profitability in the productive sector of the US economy was weak and falling and has not really recovered since the end of the Great Recession.

The conclusions of my presentation were that:

1) the Keynesian view that effective demand and investment drive profits is logically weak and empirically unproven;

2) the Marxist view is that profitability and profits drive investment in a capitalist economy.  This is theoretically logical and empirically supported;

3) this implies that it is the Marxist multiplier (the changes in real GDP relative to profitability) that is a better guide to any likely recovery in a capitalist economy than the Keynesian multiplier (changes in real GDP relative to government net spending – dissaving) and

4) Keynesian fiscal (and monetary) stimulus policy prescriptions are unlikely to work in restoring investment, growth and employment in a capitalist economy – indeed they could even delay recovery.